Paul Krugman jots some very interesting thoughts about rents in the now-future economy. Brad DeLong notes that investment seems healthier than Krugman implies. But there’s more to the story.

Here are two stylized facts about the American economy:

• Over the past 30 years the share of incomes captured by the top 1% has soared.
• Wage’s share of income has fallen with preponderance of capital.

You would gather from this that ownership of capital is highly concentrated in said top 1%. You would be right. Under capital-biased technological change you would further gather from this that a random dollar earned in the top 1% is increasingly likely to derive from capital. You would be very wrong:

Since the onset of labor’s decline in the ’70s, wage share of the top 5% has gone up by as much as it has fallen for the country as a whole. There’s been some volatility in the last 20 years, though. On the other hand, in 1960 the top .01% earned almost 20% of their income on dividends. That figure stands at 7% today:

These data are from the highly useful “World Top Incomes Database”. By the way, it’s worth noting that the dynamics among the top 5% are driven by the 1%, and really the top .05% who control an inordinate amount of that income. Looking at the contrast between the national and top economies, we can deduce that either principal-agency dilemmas have become far more pervasive over time or there’s a lot more to the story than Krugman’s model.

Look, I’m actually pretty favorable to the former explanation. Because the top 5% is driven by the top .05%, which disproportionately consists of CEOs who just happen to be their own chairman, salary accruals have skyrocketed. But a lot of it has to do with two M’s and a J: MBA, MD, and JD. The majority of America’s rich aren’t actually entrepreneurs saving the world in Silicon Valley, as the Republican party may have you believe. Instead, they are largely, boring, rentier doctors, lawyers, and management earning huge excesses either because of government subsidy (doctors and lawyers) or network effects (businessmen). – Note I think lawyers play a crucial role for American society, but do believe a certain subset has benefitted enormously from government action.

Before I go on, I want to clarify my qualms with Krugman’s sketch. As the economy monopolizes, income is diverted from labor into what Krugman argues are rents. But his consideration is limited to where the income goes, not from where it comes. Even within a labor-intense class, as America’s rich surprisingly are, much of the wages can be unproductive rent. Using a Stiglitz-Dixit framework leaves the reader with the implicit assumption that labor income is somehow more productive than anything else. In fact the whole “labor share is falling” meme across the liberal blogosphere does this.

In better days – where the top 5% did not control so much of national product – this might be true. But today, it is not. The cartelization of America’s professionals through elite networking organizations (known to some as the “Ivy League” and others as the “AMA”) have sent consulting and medical wages well above their natural level.

And the subsidy to lawyers is even more infuriating. Indeed, every time the government passes a law, it ipso facto subsidizes legal practices across the country. Not the honest public defender in Omaha, mind you, but the corporate litigator in Manhattan. This is not a question of regulation, but the type thereof. Deregulation is never instituted in sweeping form so as to actually reduce market power of lawyers. Rather, the axis of evil between firm-LLP-lobbiest-legislature ensures maimed regulation in the form of loopholes only ultra-rich firms can realize.

Unionization – of doctors, lawyers, and corporate America – is on the rise. Not surprisingly, the labor share thereof is as well. Therefore I don’t like to think that income is being diverted from labor (and capital) into monopolistic rents. They’re not making it into corporate profits in the first place, but accruing in the form of “wages” which are really just rents. But why are profits going up then? I think Paul Krugman gets the symptoms right. Capital biased technical change doesn’t explain everything. Instead, because capital rents are falling, the owners thereof (top 5%) are leasing it out at an increasingly low rate, allowing profit to accumulate.

At the end of the day, we’re both describing the same situation with a different transmission mechanism. But this difference isn’t superficial. Paul Krugman says Apple’s earning rents because, it’s… well… Apple! What can the government do about that? Not very much. On the other hand, if you see the rising rents accruing in upper income wages as not the symptom, but the cause, you can identify the disease and implement a swift cure:

• Mandate better best practices (CEO cannot be chairman).
• Get rid of the AMA and implement a single-payer system. Or institute wage controls.
• Write simpler (not weaker) regulatory law or, if this is impossible because of private interests, countersubsidize the market with a flood of corporate lawyers.
• Focus on earned income, and not capital gains, taxes. Yes, most capital gains goes to the top 1% but all income earned over $400,000 goes to the top 1%.

I’ve also argued (and here) that contestable markets are better framework for the tomorrow-economy. I’ll leave more detailed deliberations, other than the linked, for later, but suffice to say that seeming giants like Google Reader have proved to be operating under nothing less than the threat of fierce competition, preventing the assumption of monopolistic rents.

Is ownership of intellectual property important? Yeah. But it is a longshot to assume that patents are wholly wasteful. They are definitely a strong incentive to create and invest. And rents earned thereof aren’t permanent – indeed Moore’s law compels rapid intellectual capital consumption, if you will. Usually when I hear people complain about patents, I sense the underlying argument is redistribution of brand. Could we let another company copy Coke’s logo or Nike’s slogan?

I can’t come to any grand conclusion, here. But we are having the wrong conversation if we’re talking about all time low wage share of the top 100% without talking about the all time high wage share of the top 1%. And if I am onto something, the problem is a lot easier fixed than either DeLong or Krugman suggest. On this note, something that we should correct:

The above graph depicts the chance a randomly selected wage earning goes to the top 1%. It’s a simple calculation. We know that:

p(1% | wage) = p(1%)*p(wage | 1%)/p(wage),

p(1%) is the share of all income collected by the top 1%, p(wage | 1%) is the wage share of said income, and p(wage) is the wage share of all income. This is very interesting in how it compares to dynamics overall:

A given dollar earned in wages (as opposed to land rents, interests, or dividends) is more likely to fall towards the rich than dollars earned overall. I’m not sure about everyone else, but this surprises me. We need to stop talking about capital. A lot of inequality looks like it can be solved by fixing the principal-agent problem, and breaking America’s ridiculous unions. Not of autoworkers or teachers. But of doctors, lawyers, and MBAs. Indeed, the rents earned by these three professions can be considered as a risk-free return (guess what the risk of an MBA from HBS is!) To the extent that the IQ of such falls broadly in the same range as potential entrepreneurs (who may not even know their latent skill), rents earned in these industry not only increase inequality, but asphyxiate entrepreneurial spirit by allowing an easy way out.

Ben Bernanke said recently:

The only way for even a putative meritocracy to hope to pass ethical muster, to be considered fair, is if those who are the luckiest in all of those respects also have the greatest responsibility to work hard, to contribute to the betterment of the world, and to share their luck with others. As the Gospel of Luke says (and I am sure my rabbi will forgive me for quoting the New Testament in a good cause): “From everyone to whom much has been given, much will be required; and from the one to whom much has been entrusted, even more will be demanded” (Luke 12:48, New Revised Standard Version Bible). Kind of grading on the curve, you might say.

I do not want to live in a society where Yale Law and then Wall Street is that which we demand of our best and brightest.

(I do understand there are some mind blowingly excellent MBAs, MDs, and JDs out there. I also think, on average, the profession earns more than it should via government protection).